How the Rich Use Philanthropy to Dodge Taxes

The power imbalance between charities and the wealthy donors and foundations that support them leads to a lot of tongue-biting by the supplicants. And that leaves a relatively small group of people who know how the nonprofit world works and yet are independent enough to speak out about what they see as hard truths.

Ray D. Madoff, author of the new book, The Second Estate: How the Tax Code Made an American Aristocracy, is one of these people. Madoff, a law professor at Boston College Law School, has carved out a side gig as a gadfly to big philanthropy, most significantly in 2020, when she and billionaire John Arnold drafted a legislative proposal designed to spur private foundations and donor-advised funds to give away more money faster.

It didn’t succeed.

If Madoff advocates for an idea — like making the rich pay their fair share, or ensuring that charitable gifts actually get to charities in short order — there’s undoubtedly a lobbyist on the other side. She’s the rare expert whose proposals have been opposed across the ideological spectrum, including by the Council on Foundations, Independent Sector, and Philanthropy Roundtable.

The title of her new book refers to the nobility in prerevolutionary France, whose privileges included not paying taxes. The book looks at how America’s ultra-wealthy — including billionaire business owners and inheritors — aren’t subject to the same rules as the rest of us. That’s because the tax rules governing capital gains and estates — and yes, philanthropic gifts — have loopholes that allow the ultra-wealthy to dodge taxes in a way that income earners cannot.

The Chronicle recently spoke to Madoff about her book, which is out this week.

This interview was edited for length and clarity.

Why did you write this book?

It was due to a frustration that I felt around conversations about taxing the rich. One of the most troubling subtexts is that the tax code is too complicated for people to understand, and therefore they shouldn’t bother. Or that the rich will always find ways to avoid taxes — therefore, you don’t have to get engaged with a topic that is boring and complicated. People can easily understand the problems with our system, and the system can be fixed to be more equitable. It’s not too hard.

How does philanthropy fit into what you describe as the “tax-avoidance playbook”?

Philanthropy is often presented as something that is a great deal to the public. But that description often underestimates the cost of philanthropy to the public, and overestimates the benefit. In terms of cost to society, our charitable tax rules provide a two-tiered system — one for people who have earnings and one for people who have wealth. And for people who have earnings, there are often little to no tax benefits from their charitable giving. When it comes to the wealthy, they play under a different set of rules — they play under the rules of the capital-gains benefit and the estate and gifts tax benefit, and together these provide extensive benefits, worth up to 60 percent of the donation.

You write that the federal government no longer tracks the cost of these benefits, so their precise value is unknown. But you argue that these philanthropic benefits — paying no tax on appreciated gains, and no tax on holdings that would otherwise be subject to gift and estate taxes — is costing the government “a lot more” than the annual cost ($64 billion in 2024) of the charitable income tax deduction. Why is that?

Most wealthy people are giving appreciated property, and so their tax benefits are significant — up to 60 percent — without any income-tax benefit. And one of the things that I write about is how they hide that fact from the public. Surprisingly, in the case of two of our most favored billionaires — Gates and Buffett — they do so explicitly, in a peculiar fashion. They go out of the way to tell the public how few tax benefits they’re getting, which seems rather odd. These are sophisticated people. They don’t ‘not know’ that they are getting these benefits. Why are they doing this?

The book notes that wealthy philanthropists often think their own solutions to social problems are the best, but you point out that that view can lead to problems. What can we learn from one of the examples in your book — the efforts of the Carnegie Corporation and other early foundations a century ago to legitimize the eugenics movement?

If we go back to that famous 2008 book by Bishop and Greene, Philanthrocapitalism: How the Rich Can Save the World, that was a book that was very much of the era that thought it was appropriate to have the rich solve the problems of society because they are not limited by the slowness of government and other actors. It’s one thing if they’re spending their own money — but we are making a significant public investment in the donations of the wealthy. To just think that whatever they do is by definition ‘good’ is, to my mind, silly.

The point about Carnegie is that people can make mistakes — and when they have the hyperagency bestowed by great wealth and tax benefits, those mistakes can have far-reaching consequences and cause much bigger problems than some of the slower methods of addressing problems where there’s room for correction.

The upshot of your book is that the ultra-rich, unlike other Americans, are able to opt out of the tax system. While that might be bad for the country — and unfair to the average American — we live in a time when charities are more dependent than ever on the wealthy for financial support. Would your remedies be good or bad for the nonprofit sector?

There are two sets of proposals in this book when we speak about the issue of philanthropy. One is related to the tax benefits given to the wealthy — that is going to be of concern to other taxpayers who may be paying more in taxes and not having their charitable tax benefits subsidized to the same extent.

There’s a second question: What is the public getting for this money, for these significant investments of [federal] matching grants? And the problem is that our current tax rules are no longer ensuring that charities are getting any money at all.

The donor-advised fund, of course, provides no assurance of the money getting to charity — and the existence of donor-advised funds undermines the payout rules required of private foundations.

When it comes to philanthropy, what are the solutions?

The most important solution is to reconnect charitable giving to charitable activities. The way to do so is to provide that money has to either go directly to charities that are engaged in charitable activities — or if it’s going to an intermediary, that there be a meaningful payout rule — so that people don’t get tax benefits for simply putting money aside with no requirement that it ever be spent. That is the single most important change that I advocate.

As for the tax benefits for the wealthy, we should apply the same principles that we apply to income earners. So if we provide a 50 percent cap on charitable deductions for income earners, we could provide the same 50 percent cap for capital gains or estate and gift taxes. We would still incentivize charitable giving — but recognize that supporting the cost of government is also an obligation.